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Unraveling the Secular Stagnation Story

Secular stagnation is said to be present when economic growth is
negligible or nonexistent over a considerable span of time. Today,
secular stagnation has become a popular mantra of the chattering
classes, particularly in the United States. The idea is not new,
however.

Alvin Hansen, an early and prominent Keynesian economist at
Harvard University, popularized the notion of secular stagnation in
the 1930s. In his presidential address to the American Economic
Association in 1938, he asserted that the U.S. was a mature economy
that was stuck in a rut. Hansen reasoned that technological
innovations had come to an end; that the great American frontier
(read: natural resources) was closed; and that population growth
was stagnating. So, according to Hansen, investment opportunities
would be scarce, and there would be nothing ahead except secular
economic stagnation. The only way out was more government spending.
It would be used to boost investment via public works projects. For
Hansen and the Keynesians of that era, stagnation was a symptom of
market failure, and the antidote was government largesse.

Hansen’s economics were taken apart and discredited by many
non-Keynesian economists. But, the scholarly death blow was dealt
by George Terborgh in his 1945 classic The Bogey of Economic
Maturity. In the real world, talk of stagnation in the U.S.
ended abruptly with the post-World War II boom.

Today, another Harvard economist, Larry Summers, is leading what
has become a secular stagnation bandwagon. And Summers isn’t just
any Harvard economist. He was formerly the president of Harvard and
a U.S. Treasury Secretary. Summers, like Hansen before him, argues
that the government must step up to the plate and invest in
infrastructure to fill the gap left by deficiencies in private
investment. This, he and his fellow travelers argue, will pull the
economy out of its stagnation rut.

The secular stagnation story has picked up a blue-ribbon array
of establishment voices. They all preach the same gospel: the
free-market system is failing (read: stagnating). Only government
infrastructure investment can save the day. President Obama’s
Council of Economic Advisers devotes an entire chapter in its 2016
Annual Report to “The Economic Benefits of Investing in U.S.
Infrastructure.” And the President’s advisers have plenty of
company at the Federal Reserve. Both the Fed’s Chairwoman Janet
Yellen and Vice Chairman Stanley Fischer have recently called for
more government investment in infrastructure as a way out of the
U.S. stagnation rut. The list of notable adherents to the secular
stagnation story seems to grow with each passing day.

The adherents come from all sides of the political spectrum,
including the two major candidates for the U.S. Presidency: Hillary
Clinton and Donald Trump. Clinton, for example, calls the need to
upgrade the nation’s infrastructure a “national emergency” —
one she proposes to solve with a mega-government infrastructure
investment program. Indeed, Clinton’s plans would probably run up a
bill that would exceed President Obama’s proposed $478 billion
infrastructure program — a program that Congress repeatedly
rejected.

And then there is Donald Trump. While short on specifics, a
principle Trump call to arms centers on the renewal of America’s
aging infrastructure. So, when it comes to the issue of secular
stagnation and its elixir, Clinton and Trump share common
ground.

Now, let’s take a careful look at the story that has captured
the imagination of so many influential members of the
establishment. For evidence to support Summers’ secular stagnation
argument and his calls for more government investment, he points to
anemic private domestic capital expenditures in the U.S. As the
accompanying chart shows, net private domestic business investment
(gross investment - capital consumption) is relatively weak and has
been on a downward course since 2000.

Investment is what fuels productivity. So, with little fuel, we
should expect weak productivity numbers in the U.S. Sure enough, as
shown in the accompanying chart, the rate of growth in productivity
is weak and has been trending downward. Indeed, the U.S. is in the
grips of the longest slide in productivity growth since the late
1970s. This is alarming because productivity is a key ingredient in
determining wages, prices, and economic output.

When we move to aggregate demand in the economy, which is
measured by final sales to domestic purchasers, it is clear that
the U.S. is in the midst of a growth recession. Aggregate demand,
measured in nominal terms, is growing (2.93%), but it is growing at
well below its trend rate of 4.75%. And that below-trend growth in
nominal aggregate demand has characterized the U.S. economy for a
decade. To put this weak growth into context, there has only been
one other recovery from a recession since 1870 that has been as
weak as the current one: the Great Depression.

The three pillars of the secular stagnation story — weak
private investment, productivity and aggregate demand —
appear to support it. But, under further scrutiny, does the secular
stagnation story hold up?

To answer that question requires us to take a careful look at
private investment, the fuel for productivity. During the Great
Depression, private investment collapsed, causing the depression to
drag on and on. Robert Higgs, a Senior Fellow at the Independent
Institute, in a series of careful studies, was able to identify why
private investment was kept underwater during the Great Depression.
The source of the problem, according to Higgs, was regime
uncertainty. Higgs’ diagnosis is best summarized in his own
words:

Roosevelt and Congress, especially during the congressional
sessions of 1933 and 1935, embraced interventionist policies on a
wide front. With its bewildering, incoherent mass of new
expenditures, taxes, subsidies, regulations, and direct government
participation in productive activities, the New Deal created so
much confusion, fear, uncertainty, and hostility among businessmen
and investors that private investment and hence overall private
economic activity never recovered enough to restore the high levels
of production and employment enjoyed during the 1920s.

In the face of the interventionist onslaught, the U.S. economy
between 1930 and 1940 failed to add anything to its capital stock:
net private investment for that eleven-year period totaled minus
$3.1 billion. Without ongoing capital accumulation, no economy can
grow . . . .

The government’s own greatly enlarged economic activity did not
compensate for the private shortfall. Apart from the mere
insufficiency of dollars spent, the government’s spending tended,
as contemporary critics aptly noted, to purchase a high proportion
of sheer boondoggle.

Higgs’ evidence demonstrates that investment was depressed by
New Deal initiatives because of regime uncertainty. In short,
investors were afraid to commit funds to new projects because they
didn’t know what President Roosevelt and the New Dealers would do
next.

Moving from the Great Depression to today’s Great Recession, we
find a mirror image. President Obama, like President Roosevelt, has
created a great deal of regime uncertainty with his propensity to
use the powers of the Presidency to generate a plethora of new
regulations without congressional approval. In a long report, the
New York Times of August 14th went so far as to hang the epithet of
“Regulator in Chief” around Obama’s neck. What a legacy.

Once regime uncertainty enters the picture, the secular
stagnation story unravels. Private investment, the cornerstone of
the story, is weak not because of market failure, but because of
regime uncertainty created by the government. The government is not
the solution. It is the source of the problem.